Gottliebsen's Week: Banks, Sharemarket dangers, Rates, Earnings, Superannuation

Last Night

Dow Jones, down1.3%
S&P 500, down 1.8%
Nasdaq, down 3.2%
Aust dollar, US70.7c

Banks

During the week I turned 75. Never in my wildest dreams did I ever conceive that I would still be writing 10 years after the “mandatory” retirement age of 65.

I continue to write because I enjoy it and because people keep reading my work, even though they don't always agree. And then there is the money. 

What I am doing is made possible by the internet and it underlines that in many occupations mandatory retirement expectations can sometimes be very wrong (both ways). But what I have also discovered is that as you get older you get more conservative and it is a warning I give my Eureka readers periodically.

And what a week it was to have a birthday – with markets globally gyrating in both directions. So let me put down some of what I learned and noticed from the big developments of the last week and you can compare my observations with your own. And as you will see further down, the week ended with a classic destruction of two major groups of traders, including those who shorted BHP.

The first and most fundamental change we are watching is the incredible global nervousness about banks, particularly big banks. In January banks, rather than energy stocks, were the main contributors to the fall on Wall Street and they have been hit hard in the UK and Europe. I will come to Australia in a moment, but NAB chose a bad time to split off its UK bank.

In America there is considerable fear that the banks, investment banks and hedge funds have loaned far too much to energy companies and emerging economies so there are big losses yet to be crystallised, even though the bulk of the lending has been outside the banking system.

The European banks suffer from part of that problem but also in Europe there is the refugee influx that has taken the momentum out of the recovery as they focus on the enormous social problems. 

In both the US and Europe we are dealing with an unquantifiable problem which always makes markets nervous. If it turns out that the level of problem loans in the financial community is far less than the market is now predicting we will see a rise in global bank stocks. And the crunch time is nearing because the forward selling of oil by US oil and gas producers starts running out next month. In Australia we might catch the global backwash via our banks' need for overseas borrowing if the overseas crisis turns out to be large.

But here we are much more concerned with the fact that our banks have lifted their dividends to what are unsustainable levels. In the coming bank profit season we will probably start to see dividend reductions. ANZ and NAB are the two most likely candidates but Westpac is not far behind. Commonwealth Bank could hang on longer than the other banks if it chooses to.

Banks have been forced to raise more capital to lower their risks so there are more shares to service from a profit pool that is no longer expanding rapidly. There is a limit to how far you can raise lending rates and give depositors another kick.

Banks need to invest in technology because in Australia and around the world the banking industry has been targeted by low-cost disrupters seeking to use technology to take slices of the banks' market share. To defend themselves banks need to be lower cost. To be lower cost requires additional investment, which is made more difficult when you are paying out around 80 per cent of your profits when the international norm is around 50 per cent.

Sharemarket dangers

The second lesson from the week just gone by is just how much equity traders are dominating our global and local markets. The dramatic swings up and down reflect heavy shorting and then short covering only to go to long.

These are wild times because our investment banks are hungry for profits and have low-cost capital at the ready. Many have pipes into stockmarkets, particularly in the US, which gives them an advantage over retail investors and they seek to use that advantage by dominating markets.

This makes it dangerous for the average investor to be buying or selling when the market is absolutely out of control either way. If you want to increase your equity exposure to the market or a particular stock try do it when there is a slump and sell on a run up. 

In the global trading game there have been two truly massive positions. Firstly, traders were long US dollars because they were anticipating rate rises, and when the US dollar began to fall as the rate rise prospect vapourised, there was a massive trader sell-off in the US dollar.

Conversely, traders were massively short oil and resources stocks such as BHP and Vale and to a lesser extent Rio Tinto. When oil started to rise and there was a Samarco settlement, BHP and Vale began moving up so there was a scramble by the shorters to cover. We saw Vale sky rocket over 11 per cent and BHP rose more than 4 per cent in the local market. Later, I will discuss taking an energy position for the longer term. If you are jittery about resources stocks now is your chance to get out because there could easily be a fall back once the short positions are covered.

As I mentioned last week, I have trimmed my equity exposure. I would have been better to wait a week but that's life. Abhorrent as it is, the dominance of traders in leading stocks will not go away, but it will push more people into property and is underlining that there is more stability in smaller and medium-sized companies, where there is simply not the liquidity in the market for traders to undertake such activities, unless a particular stock gets a huge boost or runs into deep trouble.

Rates

I know I have written on this before, but we have seen a rush of money to the US and Australian bonds which has sent yields plummeting. The market no longer expects a US rate rise and if there is one in 2016 it will be isolated. That increases the value of yield. 

Here in Australia, with the US markets no longer expecting significant interest rate rises and the long positions in the US dollar being unwound, our dollar has risen and could rise further.

So, abhorrent as it might be to bank depositors, the events in the US are making interest rate reductions in Australia more likely as we seek to curb the dollar rise. And that prospect has been enhanced by the fact that the heat has been taken out of the residential property market. There is no collapse but prices have started to ease in many areas of Sydney and Melbourne. But in Sydney, at least, apartment rents are on the rise, which will put a floor under the falls.

As in so many Australian activities, dwelling prices in Sydney and Melbourne have been set by Chinese buying. There is no sign of it stopping but it is always a danger.

There has been an incredible focus on the price of oil. Picking a bottom in a market like oil is nearly impossible. With Iran's production coming onto the market and oil stocks high there is a clear possibility of another sell-off. But we are approaching the bottom because as those high-priced forward oil sales in the US start to run out we should see a fall in oil production in the US. If that happens, it will encourage both OPEC and Russia to trim production.

An oil price of below $US30 a barrel is not a sustainable level because over time it will reduce production too far. So if you are prepared to make a small investment in well-funded energy stocks once the short covering is over and put them away, you might do well longer term.

Earnings

We are now just about to enter our profit season. I don't think it is going to be a spectacular one. Trading in many areas is tough out there and a lot of companies are going to report relatively low levels of growth.

At this stage you would like to think that most of the disasters that are ahead of us are well known. They will be led by our resources companies and Woolworths, and there will be other negative surprises we might not expect.

But there will also be some good results. Indications are that Harvey Norman, JB Hi-Fi, Qantas and Wesfarmers should all do well. But, as always, if a stock does a great deal better than expected the share price will jump, while conversely, disappointing results will see the institutions trash the stock. If you are confident that a company doesn't have deep underlying problems, there is money to be made if earnings disappoint because the institutions simply sell, irrespective of value. 

Superannuation

And finally, I will return to superannuation at a later date, but the current reporting from Canberra indicates that the Coalition government will increase the tax on higher income contributions to superannuation but leave the current tax-free pension mode status untouched.

In the horse trading in the Senate that might change and, of course, the ALP plans to tax superannuation funds in pension mode.

The great problem that you have in saving for retirement is that you don't know how long you are going to live and therefore how much money you need. However, when you reach 75 you become conscious of the fact that the government is now going to require you to pay a higher proportion of your superannuation assets in annual pension. I have no objection to this but it does begin the process of running down the level of your fund unless stockmarkets rise sharply.

Last Week

By Shane Oliver, AMP

Investment markets and key developments over the past week

The past week has seen most share markets give up much or all of their Fed and Bank of Japan inspired gains of the previous week as some soft US data added to concerns about the US and global growth outlook. Bond yields generally declined except in peripheral Eurozone countries. Commodity prices were mixed with metals up but oil down a bit, as a weaker US dollar provided some help. The weaker US dollar has also seen the Australian dollar push back up to around US72c.

Perhaps the big development over the last week was the decline in the US dollar. This was on the back of soft US economic data along with Fed Governor Brainard and NY Fed President Dudley reinforcing the view that the Fed is on hold. The strengthening US dollar in recent times has played a role in market turmoil to the extent that it added to the weakness in oil and commodity prices, put downwards pressure on emerging market currencies adding to the risk of a funding crisis, put pressure on China to depreciate the Renminbi and weighed heavily on US profits. So if the US dollar can stabilise then it could be positive for share markets and commodities.

Against this, concerns around global growth, particularly about China and the US, are likely to linger so it remains premature to say we have seen the low for shares. In particular, a weaker US dollar will be of no help if it's due to a slumping US economy.

The key therefore remains whether we will see a US/global recession. If we do then share markets have much further to fall (eg, another 20 per cent plus). But if recession is avoided and global growth continues to muddle along around 3 per cent pa then further downside in markets is likely to be limited and they are likely to stage a decent recovery by year end. We see a recession as being unlikely because we have not seen the normal excesses – massive debt growth, over investment or inflation – along with aggressive monetary tightening that invariably precede them. In fact, we are still seeing aggressive global monetary easing. At this stage we see the probability of US/global recession as being around 25 per cent.

While the RBA left interest rates on hold for the ninth month in a row the tone of its post meeting statement and its February Statement on Monetary Policy signals greater concern about the global growth outlook and a watching brief regrading recent financial turbulence suggesting that it has become a bit more dovish. Our view remains the RBA will cut interest rates again this year reflecting the risks around the global economy, weaker than expected commodity prices, still subdued growth in Australia at a time when the contribution from housing construction is slowing, a more dovish Fed threatening a higher Australian dollar and continued low inflation. However, this may not be till April or May.

Should investors worry about the Zika virus? Put simply - no. While its implicated in birth defects, people usually don't get sick enough to go to hospital and rarely die so it doesn't compare to Bird Flu, Ebola or SARS in terms of potential economic effects.

Major global economic events and implications

US economic news over the last week was a bit on the soft side adding to concern about a slowdown in US economic growth. While ISM manufacturing conditions index rose slightly it remains weak, the ISM non-manufacturing conditions index fell raising concerns that manufacturing weakness is affecting the services sector, construction activity was weaker than expected in December and the Fed's bank lending officer survey showed tightening lending standards for business loans and reduced loan demand. However, all is not negative as the Markit manufacturing PMI is much stronger than the ISM, auto sales were stronger than expected in January, bank lending standards to households are not tightening and jobs data is okay. More broadly the US economy could be going through just another soft patch of which we have seen several over the last six years over which time annualised GDP growth has averaged 2 per cent pa, but ranged from -1.5 per cent to 4.5 per cent.

Sure there could be problems ahead for energy related debt and mining and energy related investment could fall further but with the latter having already fallen from 0.8 per cent of US GDP to just 0.4 per cent the bulk of the damage is arguably already behind us. So in the absence of a period of broad based excess and significant monetary tightening it remains hard to see a US recession. At this stage I attach about a 25 per cent probability to the risk of a US recession.

So far the US December quarter earnings reporting season is about 62 per cent complete. While 78 per cent of results have beat on earnings, the size of positive surprises has been lower than in prior quarters and so earnings are still down 5.6 per cent year on year. Sales revenue is down 4 per cent, but up 0.9 per cent if energy is excluded.

Eurozone unemployment fell 0.1 per cent in December, but remains high at 10.4 per cent. Meanwhile producer price inflation remains very negative at -3 per cent year on year highlighting the risk of broader deflation.

Japan's final manufacturing conditions PMI for January fell slightly to 52.3 but its services conditions PMI rose 0.9 points to 52.4 all of which is consistent with continuing growth.

Chinese business conditions PMIs painted a mixed picture for January with the official and Caixin manufacturing PMIs little changed and averaging a still soft 48.9, but the average of the services PMIs rose 0.6 points to a solid 53. Quite clearly manufacturing remains weak but services are solid. Meanwhile further help was provided for the housing sectors with another cut in minimum down payment rates for some cities.

India is doing well with manufacturing and services conditions PMIs rising solidly in January

Australian economic events and implications

Australian economic data was mixed. The AIG's business conditions indicators continue to meander around average levels, building approvals rebounded in December but continue to look like they have seen the best pointing to a declining contribution to economic growth from housing this year, retail sales were flat in December but saw moderate real growth in the December quarter and the trade deficit blew out again in December due to weak commodity prices. Home prices bounced back in January after falls in the December quarter but it continues to look like momentum is cooling in Sydney.

Next Week

By Savanth Sebastian, CommSec

Reserve Bank holds the limelight

Another big week of economic events is in prospect in Australia over the coming week including data on business and consumer confidence and housing finance.

In addition, you could be forgiven for thinking that the Reserve Bank would take a step back given the prominence it held over the past week with an interest rate decision and also with the release of the Statement of Monetary Policy.

But with the Governor fronting the House of Representatives Economics Committee on Friday, the Reserve Bank will continue to dominate investor attention.

In China, the Chinese New Year will take precedence. And in the US, Federal Reserve chair, Janet Yellen, gives testimony on the economy. US retail sales and consumer confidence data are also due.

In Australia, the week kicks off on Monday with the release of data on job advertisements by ANZ. In the past, budding employers would advertise positions in newspapers or on job websites. Now positions are more likely to be found on individual company websites or through social media. So while the data on job ads is less instructive, figures show that they have still risen for seven out of the past nine months.

On Tuesday, investors will be looking for a rebound in the NAB business survey after the December results suggested that business confidence and conditions both eased a touch in response to recent global jitters. Since the last business survey was held, oil prices and global sharemarkets have recovered from lows and central banks have vowed to maintain economic stimulus.

Also on Tuesday the Housing Industry Association will release figures on new home sales. There are signs that activity is topping out. New home sales have fallen for three consecutive months and are holding at 16-month lows. It's clear there is greater caution on the part of buyers and builders and that suggests slower price growth over in 2016.

On Wednesday, the Westpac/Melbourne Institute monthly measure of consumer sentiment is released - a survey that provides a useful check on the similar and timelier Roy Morgan weekly survey.

On Friday home loans (housing finance) and data on tourist arrivals is released. The home loan data may prove a surprise with data from the Bankers Association suggesting the number of owner-occupier home loans may have lifted by almost 5 per cent in December while the value of all loans lifted by 0.5 per cent.

While foot traffic has reduced at auction sites, if the results prove correct, it will show that the low interest rates are still an attractive reason for potential home buyers to upgrade their homes, albeit at a slower pace than what was witnessed last year.

The tourism numbers will contain the figures for the calendar year. Interestingly, tourists to Australia from mainland China have lifted to record highs. Tourists from China and Hong Kong combined exceeded 1.2 million in the past year, closing fast on the 1.3 million visitors from New Zealand.

Also on Friday the Reserve Bank governor is scheduled to appear before the House of Representatives Economics Committee. There are a few ‘hot button' issues at present and it is likely committee members will ask the Governor's views on the weakness in China, the weaker Australian dollar and the implications of the volatility in share markets and views on the concerted effort by central banks to continue to add stimulus.

Fed Testimony and retail sales in focus

Turning attention overseas, there are sparse helpings of ‘top shelf' US economic data in the coming week, with the main economic data of interest being in retail sales on Friday. However ahead of that the focus will be on the testimony by Federal Reserve chair, Janet Yellen, to the US House of Representatives financial services committee on Wednesday and her testimony to the equivalent US Senate Committee on Thursday. Investors will be hoping for clues on the timing of future rate hikes.

In terms of data the week kicks off on Tuesday with the release of the monthly US wholesale sales and inventories figures, while on Wednesday the monthly US Federal Budget is slated for release. And on Thursday the usual weekly jobless claims numbers are released.

On Friday retail sales figures, business inventories, import prices and the University of Michigan consumer sentiment index are released). Forecasts centre on retail sales lifting by 0.1 per cent in January after a 0.1 per cent fall in December. Similarly a modest 0.1 per cent lift in business inventories is expected. The preliminary January reading on consumer sentiment is expected to show a modest lift from 92.0 to 93.0.

Sharemarkets, interest rates, exchange rates and commodities

The Australian profit reporting season cranks up a notch in the coming week as the US earnings season starts to wind down. As we have noted previously, the problem in Australia is that it is difficult to accurately determine when companies are reporting. That is, there is no “official” or central calendar of corporate news or events, in part because many companies are tentative about reporting dates and make changes with little notice.

As far as we can ascertain, on Monday earnings announcements are expect from Coffey International, Ansell, Capilano, AV Jennings, and News Corp.

On Tuesday, Bradken, Cochlear, Slater and Gordon, and Royal Wolf Holdings are listed to issue results.

On Wednesday, as many as 27 companies will report earnings including AGL, Aquarius Platinum, Boral, Commonwealth Bank, Computershare, CSL, Domino's Pizza, Goodman Fielder, OZ Minerals, Stockland, Skilled Group, Skycity, and Suncorp Group.

Among companies scheduled to issue results on Thursday are ASX, Goodman Group, Mirvac, Mesoblast, Paladin, Rio Tinto, Transurban, Tassal Group, and Warrnambool Cheese and Butter Factory.

And on Friday, Automotive Holdings, GBST Holdings, Newcrest, and Sims Metal, are tipped to report.

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